On the use of collateral (original) (raw)
Related papers
Collateral, heterogeneity in risk attitude and the credit market equilibrium
European Economic Review, 1999
This paper examines the argument that the availability of collateral rules out credit rationing. A model of the credit market with ex-ante asymmetric information and heterogeneous entrepreneurs' attitudes toward risk is set up. It is shown that, due to the interplay between project choice and entrepreneurs' preferences, using collateral as a signal to screen safer projects may prove impossible. Instead, a partially separating two-contract equilibrium with rationing at one contract emerges. Contrary to previous theoretical research and consistently with conventional wisdom and systematic evidence, the use of collateral is never negatively correlated with project risk.
Why do borrowers pledge collateral? New empirical evidence on the role of asymmetric information
Journal of Financial Intermediation, 2011
An impressive theoretical literature motivates collateral as a mechanism that reduces equilibrium credit rationing and other problems arising from asymmetric information between borrowers and lenders. However, there is no clear empirical evidence regarding the central implication of this theory-that a reduction in asymmetric information reduces the incidence of collateral. We provide such evidence by exploiting exogenous variation in lender information sets related to their adoption of a new information technology, and comparing collateral outcomes before and after adoption. Our results are consistent with the central implication of the theoretical models, and may also have efficiency and macroeconomic implications.
The Role of Collateral in Credit Markets
Journal of Mathematical Finance, 2015
The author examines the role of collateral in an environment where lenders and borrowers possess identical information and similar beliefs about its future value. Using option-pricing techniques, he shows that a secured loan contract is equivalent to a regular bond and an embedded option to the borrower to default. The author finds that the lender will not advance to the borrower, a loan that exceeds the market value of the collateral, and that the supply of loans increases with a rise in the market value of the collateral. Increases in the volatility of the value of the collateral, interest rate, and dividend rate of the collateral independently depress the loan supply. The author also derives the cost of a third-party guarantee of a loan and an implied risk premium.
Tests of ex ante versus ex post theories of collateral using private and public information
Collateral is a widely used, but not well understood, debt contracting feature. Two broad strands of theoretical literature explain collateral as arising from the existence of either ex ante private information or ex post incentive problems between borrowers and lenders. However, the extant empirical literature has been unable to isolate each of these effects. This paper attempts to do so using a credit registry that is unique in that it allows the researcher to have access to some private information about borrower risk that is unobserved by the lender. The data also include public information about borrower risk, loan contract terms, and ex post performance for both secured and unsecured loans. The results suggest that the ex post theories of collateral are empirically dominant, although the ex ante theories are also valid for customers with short borrower–lender relations that are relatively unknown to the lender.
2003
The author examines the role of collateral in an environment where lenders and borrowers possess identical information and similar beliefs about its future value. Using option-pricing techniques, he shows that a secured loan contract is equivalent to a regular bond and an embedded option to the borrower to default. He finds that the lender will not advance to the borrower a loan that exceeds the market value of the collateral, and that the supply of loans increases with a rise in the market value of the collateral. Increases in the volatility of the value of the collateral, interest rate, and dividend rate of the collateral independently depress the loan supply. The author also derives the cost of a third-party guarantee of a loan and an implied risk premium.
Does Collateral Help Mitigate Adverse Selection? A Cross-Country Analysis
Journal of Financial Services Research, 2011
In this paper, we empirically investigate whether collateral mitigates adverse selection problems in a loan market. Theory predicts a negative relation between the presence of collateral and the interest spread of a loan. However, bankers’view and most empirical evidence contradict this prediction and support the observed-risk hypothesis instead. We provide new evidence from a sample of 4,940 bank loans from 31 countries. We test whether the degree of information asymmetry affects the positive link between collateral and the loan spread and find that a greater degree of information asymmetry reduces this positive relation. This finding provides support for both the adverse selection and observed-risk hypotheses.
The Role of Collateral in the Credit Acquisition Process: Evidence from SME Lending
Journal of Business Finance & Accounting, 2016
This study tests the simultaneous impact of observed characteristics and private information on debt term contracts in a multi-period setting, using a data set of 12,666 credit approvals by one major Portuguese commercial bank during 2007-2010. The main results show that borrowers with good credit scores that know they have a high probability of success and are unlikely to default are more willing to pledge collateral in return for a lower interest rate premium (IRP). Furthermore, lenders tailor the specific terms of the contract, increasing both collateral requirements and the IRP from observed risk, for borrowers operating in riskier industries and with less credit availability. The results are robust to controls for joint debt terms negotiation and the degree of collateralization offered by the borrower.
2020
In this paper we empirically test the recent lender-based theory for the use of collateral in bank lending. Based on a proprietary dataset of loan contracts written by a local bank in competitive credit markets, we use the physical proximity between borrowers and the lending branch of the bank to capture its information advantage and the magnitude of collateral-related transaction costs. Overall, our results seem more consistent with several classic borrower-based explanations rather than with the lender-based view. We show that, conditional on obtaining credit from the local bank, more distant borrowers experience higher collateral requirements and lower interest rates. Moreover, competitive pressure from transaction lenders does not magnify the importance of lender-to-borrower distance. Our findings are also obtained with estimation techniques that allow for endogenous loan contract terms and joint determination of collateral and interest rates. JEL Classification: G21, G32, L11
Collateral and Bank Credit – a Puzzle
European Journal of Economics and Business Studies
The impact of firms characteristics on bank debt financing has always been a field of conflicts among economists (e.g. trade-off theory vs. pecking order theory). The pecking order theory predicts that firms holding more tangible assets are less prone to asymmetric information problems and reduce the agency cost. Generally, the supply of bank loans is expected to be higher for firms with higher collateral. In the empirical literature, this relationship is not always confirmed. We analyse this phenomenon from three points of view: meta-analysis of literature, country level data and case of Poland. This study provides a systematic analysis of the empirical literature on the usage of bank debt by conducting a meta-analysis. In particular, the problem of publication selection bias is discussed. We explore the sources of heterogeneity among studies including moderator variables in random- and fixed effects regressions. Our results indicate that there is an evidence of publication selecti...